Time to Reconsider Conventional Investing Wisdom

High U.S. market volatility should come as no surprise. Amid election anxiety, surging new COVID-19 cases and a delay in fresh fiscal stimulus, volatility has averaged at least twice the long-run reading of around 15, as measured by the VIX Index. On Oct 28, it pierced 40, the highest level since mid-June. 

Meanwhile, extreme swings in the VIX—a rise in the volatility of volatility—suggest that some kind of structural change is afoot. We see two powerful undercurrents: a new and different business cycle and a major shift in fiscal and monetary policy, resulting from the inability of Federal Reserve policies over the past decade to generate a normal level of growth.

Already, investor attitudes have begun to change—and to acknowledge that certain policies, such as government spending, regulation, inflation and deficits, may be necessary ingredients for economic growth. As a result, I expect three policy-related tenets of conventional investing wisdom to reverse:

• Political gridlock: It is generally seen as positive for markets when rival political parties control different branches of government, mainly because it limits potential for new regulation and tax increases. However, we believe investors are slowly embracing the need for a greater level of cooperation and compromise in Washington than we’ve seen lately. This could lead to more government spending, including pandemic relief and infrastructure spending, which stands to create jobs and boost incomes.

• Higher taxes: Many investors regard increased government spending, especially when funded by tax increases, as an impediment to corporate earnings and economic growth. However, the COVID-19 recession is occurring against a backdrop of record deficits and debt. With now historically low interest rates potentially headed higher as growth picks up, this debt load could increasingly drag on the economy and weigh on the dollar, squeezing out other government spending. Financing that debt likely will require new revenues. Reforming the tax code, including raising corporate taxes, may be unavoidable.

• Rising Inflation: Investors often fear inflation, which has triggered bear markets in the past. However, the Fed’s new “average inflation targeting” framework could allow inflation to float above the 2% target for years to make up for the past decade when inflation has mostly been below that level. Investors have yet to grasp fully this sea change. Importantly, a healthy level of inflation can serve many purposes, including stimulating current consumption vs. savings, which could support growth and lessen the burden of high debt, since borrowers essentially would be repaying loans with dollars that are worth less.  

We believe the next business cycle, combined with these likely policy shifts, will produce fresh market leadership centered on capital investment, infrastructure, housing and strong consumer spending. I suggest that investors consider repositioning portfolios toward select sectors, including financials, industrials, clean energy, construction, consumer durables and service-sector automation, and away from the digital and technology-related “work-from-home winners” of 2020.

This article is based on Lisa Shalett’s Global Investment Committee Weekly report from Nov 2, 2020, “Challenging Convention.” An upcoming paper expands on these themes in greater depth. Ask your Financial Advisor for a copy or find an advisor. Listen to the audiocast based on this report.